University:
Stanford University
Course:
ECON 202 | Microeconomics I
Academic year:

2023
Views:

128

Pages:

2
Author:

T. Elton

Competitive Bidding This occurs when competing firms are asked to submit their individual bids for a particular contract. Obviously, the problem facing a firm in this situation is the uncertainty regarding the prices at which the competition will tender, because a supplier will wish to pitch his own quote at a figure which is sufficiently attractive to secure acceptance, but at the same time not so low that a loss might ensue (unless the contract is regarded as a loss leader). In other words, the bidder will wish to increase his probability of winning the job, without sacrificing more profit than is absolutely necessary. Models employed in this situation will take explicit note of the possible positions adopted by competitors, and use simple probability theory to determine the most profitable course of action to adopt. Table 11.3 is an example of such a model. The firm's own marginal costs must be calculated, together with the probability of a bid being successful within a particular price range - this latter will be the major variable, and could be estimated from past bidding behaviour by competitors and a knowledge of previously successful bid prices for similar contracts. Note that costs should include opportunity costs, if a successful tender would prevent other, profitable, work from being undertaken during the life of the contract. As can be seen, a quote of £860,000 gives the highest expected profit, and provides the most satisfactory trade-off between probabilities and profit. Whenever a quantitative model of this type is employed, it is worth emphasizing that the future will always be uncertain; probabilities are often only estimates; and the 'expected profit' will almost never be a feasible outcome (the actual profit on a bid of £860,000, according to the table, could only be 180,000, ceteris paribus). Finally, it is worth noting that there are very few business problems that can be reduced to a simple quantitative analysis - qualitative factors must always be taken into account. In this situation, for example, the contract might not necessarily be awarded on the basis of the lowest bid; reliability and a reputation for good quality work might also be considered by the firm awarding the contract. For a detailed discussion of this topic and its theoretical underpinnings, the reader is referred to Oxenfeldt et al. (1961) and Edelman (1967). Table : Competitive Bidding